We Need a New Staggers Act
In an effort to create a friendly regulatory environment to operate within, railroads are slowly poisoning themselves to death while their worst impulses are incapable of being checked.
Bob the Builder Follow up
Writer’s remorse? I don’t know if there’s a term for it, but sometimes I publish and then realize what I just put out there is largely garbage (in my opinion). I enjoy the accountability of trying to write regularly, but can’t help but think the quality would go up with a little extra marinading. Writing in short 15 min bursts between meetings or when I can catch WiFi on the plane doesn’t help either.
There are a couple more ideas I wanted to include in my last article:
Renewable biofuels as a growth area have stalled out. This should really come as no surprise. When I left ADM in 2018, one reason I did so is because all of my skills and experience (running large capital projects, subject matter expertise in soy crush processing) was going to waste. No one was building new plants and there wasn’t a lot of exciting things going on.
Not long after that, the crush boom rolled through on the back of LCFS (low carbon fuel standard) legislation and other tax and regulatory friendly policies to incentivize renewable diesel. But any regulatorily driven demand is artificial; It’s not what the market would naturally come to. Therefore, as soon as whatever artificial supports are gone, the demand is gone as well.
Using row crops in new markets like fuel is great for the American farmer, but the less energy dense medium is always going to lose out to fossil fuels.
The absence of growth in the renewable diesel market is just one more disappointing area that reduces future new build demand.
FreightCar America is doing pretty well. I didn’t comment on any of the builders in my last article outside of the two big dogs (GBX and TRN), but I think Freight Car America’s recent performance deserves some kudos. They were trading as a penny stock from September 2019 up until last year. With their large exposure to the coal market, they’ve arguably fared worse than most any other company in the industry with coal’s decline. FreightCar started investing in oither product lines, shifted production to Mexico, and, by all accounts, were a wonderful supplier for shippers acting nimbly and aggressively to win deals. They’re a distant third, but I think it’s worth highlighting their turnaround.
What Are We Solving For?
Just this past week, a US Appeals Court decided that the STB’s service-based reciprocal switching rule exceeded their statutory authority. The court decided that the STB has to first identify a case of inadequate service before it can supply a remedy in the form of reciprocal switching.
I don’t know why for certain, but based on the Board’s arguments for the rule it was clear that they were tiptoeing around actually determining what adequate service is, in an overly prescriptive manner at least. So what is the right framework for determining if some injustice has been committed? Competition? Good Service?
Any US governmental policy should serve two primary functions:
Protect the rights of parties.
Promote the economic well-being and security of parties.
With that in mind, effective freight rail transportation policy should be designed to uphold those functions. I would encapsulate it all in seven words:
Reduce the total cost of rail transportation.
That’s it. If our regulators did that, they would bring about the most prosperous, innovative, and efficient mode of land transportation in the country.
US rail policy should focus on taking costs out of the system to drive the largest benefits to the rail industry specifically and the country broadly. Why is this the right focus?
First, a reduction in land transportation costs for freight makes US domestic producers more competitive internationally and stretches the US consumer’s dollar farther. The North American rail network is a key competitive advantage for US bulk producers like grain, coal, and chemicals. This then spurs greater domestic production, domestic investment, and consumption in a virtuous cycle.
Second, optimizing for the lowest total cost of rail transportation drives operational waste out of the system. Some common signs of waste include poor rail velocity, elevated car counts, extended dwell, misplaced or lost cars, too many cars ordered by shippers, misplaced or poorly allocated crews and power, unnecessary or excessive maintenance of track and equipment, and on and on. In other words, any operational inefficiencies add cost and friction to driving greater rail freight volumes.
Third, this focus drives commercial and administrative inefficiencies out of the system. Poor IT investment holds back productivity enhancing technology adoption, like telematics and AI. Outdated EDIs, grueling rate quotes with excessive approval processes, paper pushing, manual data entry such as in car placements, endless emailed spreadsheets as the primary form of communication, poor inventory cost accounting, etc.
You might read all of that and think, “This commie idiot wants a nationalized rail transportation system with fixed prices!” Do not misunderstand me.
I am not a proponent of such a system because it wouldn’t lower the total cost of rail freight transportation. Look at Amtrak, DB, SNCF, pick any national rail service and none of them are self-sustaining; they’re heavily reliant on government subsidies and investment to keep up with CAPEX investment requirements.
And that’s fine! Some models, particularly passenger rail, may fulfill other, non-profit seeking benefits. But that’s not the correct model for the most efficient, sustainable rail industry. The federal government cannot saddle another infrastructure system when it already does such a poor job at funding basic upkeep on our roads and waterways.
Can regulation really drive a business to improve in all the ways I list above? Not directly, but I believe the proper incentive structure will naturally lead companies to pursue those outcomes on their own. One only has to look at the impact of the Staggers Act in the industry’s history to see an effective policy framework that brought back the railroads from the brink to see how proper policy can create the right incentives…for a time at least.
Staggers Act Revisited
The 1980 Staggers Act has been almost universally hailed as the poster child of effective deregulation.
Guess what one of the primary outcomes of the Staggers Act was: Lower prices.
The naked truth is that the existing regulatory framework that was designed 50 years ago is now outdated and outgrown; it does not fit the needs of our current rail network.
There’s been a lot of post-mortems written about Staggers, but all of those were done more than 15 years ago. You find a lot of charts like the ones below from the Cato Institute which show a dramatic drop in real rail rates by almost 50%.
Except, what does that chart look like if you extend it out to 2025? Like the chart below from FRED. Have all the pricing reductions for shippers post-Staggers been erased?
Long-time readers know that my thesis on railroad strategy was that a switch was flipped post-merger mania in the early aughts to extract as much gains out of the newly formed systems. This was fertile ground for PSR in reducing OPEX while driving up prices. Still today, pretty much all the Class 1’s state their strategic objective is to continue to increase prices above inflation (inflation+ pricing) as a means of growing earnings.
Don’t get me wrong. Staggers and the earlier reforms in the 1970’s were the right pieces of legislation at the right time. Overdue, really. The railroads were on life support and needed a major structural overhaul. Removing burdensome regulation, allowing unprofitable lines to be abandoned (many of which became shortlines), and shifting passenger rail responsibilities to Amtrak breathed new life into the industry.
Staggers drove tremendous costs out of the system, which resulted in greater profitability for railroads, lower rates for shippers, and a sustainable cash cycle that allowed railroads to invest in much needed infrastructure renewal. Removing the barriers to realize these outcomes is why Staggers was successful.
But Staggers and subsequent legislation creating the STB do not fit the needs of the modern rail industry. The biggest productivity gains were driven by scale economies that came through the mega-mergers of the 1990’s. Since that time, we’ve been painting the trim and pruning the hedges from time to time, but the home no longer fits our needs.
The evidence that the Staggers regulatory framework has run its course can be seen everywhere in the industry:
Rail rates have been on an aggressive upward march since 2004, as highlighted by the FRED chart above. Talk to any shipper and they’ll tell you they’re paying more for less.
Shippers receive little to no relief in rate disputes due to a cumbersome, costly, never ending, and (nearly always) negative outcome that they’ve stopped even bothering to try. Many won’t even speak up for fear of retaliation. Those that dare often have never pursued rate cases before while going up against teams of rail lawyers who have plenty of notches on their belts.
Railroads continue to cede modal share to trucks, pushing more wear and tear on roads and bridges that we already can’t keep up with maintaining, more congestion on those highways, and more energy consumed and emissions released in an inferior transportation mode. Physics don’t lie, amigo.
STB reforms, such as a service-based reciprocal switching rule mentioned above, all get killed by railroad lawsuits.
In an effort to create a friendly regulatory environment to operate within, railroads are slowly poisoning themselves to death while their worst impulses are incapable of being checked.
The system no longer protects the parties it was meant to serve nor is it creating economic benefits for…anyone. The railroads are playing a game of music chairs and none of them have quite realized that most of the shippers left the party a long time ago. The STB needs to be able to take the punch bowl away and it cannot.
Staggers 2.0
So, what does an updated regulatory framework look like? What is going to lower the total cost of rail transportation without creating more harm than it seeks to alleviate?
Some ideas:
Simplify the rate review process. This cannot be overstated and is so essential. Rates need to be checked in a clear, unambiguous way that doesn’t take 10 years to resolve. Give the STB leeway in deciding what the appropriate thresholds are in a case-by-case basis. If a shipper’s rates increased by 80% in 2 years, that might be a problem. If the shipper is bringing a rate case before the board every time their rates go up, that might be indicative of a shipper abusing the system.
Ban specific anti-competitive tactics. Paper barriers, 1-mile track breaks to prevent access with a competitive carrier, they’re all garbage. Throw them out. I am more than happy to debate anyone on the merits of a paper barrier under the guise of economic justification for a “reasonable” rate of return in a lease agreement. Utter nonsense. You’re getting someone to come into your business and pay you to bring you more business. Don’t pretend like this is some great burden that you’re reluctantly bestowing upon a little shortline out of the kindness of your heart. The Class 1 benefits collects more revenue from the carloads than the shortline.
Implement reciprocal switching across the board. The only way to cure the rail industry’s ills from a broader perspective is to inject more competition into the marketplace. Not competition from trucks. The rails lost that battle decades ago. They’re no longer interested in competing with trucks. No, to save them from their excesses, rails need to compete with each other. At a minimum, reciprocal switching opens the door for more competitive options for those who can access it. It won’t help most shippers, I believe, but if it lights a fire under the railroads to actually compete on service and not just sit fat, dumb, and happy on access, then at least a part of the industry can become healthier.
There’s more I could add about the stifling nature of AAR committees on innovation or about the “lowest common denominator” incentives of how railcar maintenance is performed, but those may be outside the scope of this argument.
Now, if you’re a Class 1 you might be shaking your head at these suggestions. It’s not the 1970’s and you’re not on the brink of bankruptcy and collapse. But you also can’t be blind to the fact that every year fewer carloads hit the rails than the year before. Or that all resolutions to grow carloads have accomplished zilch. You may have carved out a favorable regulatory environment in which to operate, but you’re business is slipping through your fingers.
Rail deregulation dramatically lowered freight rates and everyone survived. If any of these actions result in lower rates or decreased margins, I don’t think you can conclude that it will kill the industry. Maybe optimizing for margin maximization isn’t bringing you profit maximization. Why don’t you try eating a smaller slice of a bigger pie instead of continuing to attack a larger slice of a smaller pie.
These ideas aren’t perfect and they don’t solve all the problems, but it’s clear that the current regulatory regime is broken in its existing state. Rate relief is inaccessible to shippers. Railroads can kill STB-driven attempts at reform at will. All while the industry continues to dwindle into irrelevance at the expense of shippers, railroads, suppliers, and, especially, the national economy.